The effect of a party’s bankruptcy on international arbitration proceedings in Switzerland – the revised position of the Swiss Federal Supreme Court after Vivendi

On October 16, 2012, the Swiss Federal Supreme Court (hereinafter “Supreme Court”) issued a decision wherein it clarified its position regarding the effect of a party’s bankruptcy on international arbitration proceedings in Switzerland.[1] The Supreme Court therewith reacted to numerous criticisms regarding its so-called Vivendi decision of March 31, 2009[2].

I.              The Vivendi decision

A.           The decision of the Supreme Court

In 2009, the Supreme Court was faced with the question of the effect of the bankruptcy of a Polish company, Elektrim SA (hereinafter “Elektrim”), on an international arbitration proceeding in Switzerland.[3] Elektrim, a defendant in the arbitration proceeding in Geneva, informed the arbitral tribunal that it had been declared bankrupt in Poland and that therefore all arbitration agreements concluded by the company ceased to exist and all arbitration proceedings ended for the company. It relied on article 142 Polish Bankruptcy Act (hereinafter “BA”), which states: “Any arbitration clause concluded by the bankrupt shall lose its legal effect as at the date bankruptcy is declared and any pending arbitration proceedings shall be discontinued.“[4] The arbitral tribunal decided to discontinue the proceeding with respect to Elektrim as the entity had lost its capacity to be a party in the arbitration proceeding pursuant to article 142 BA.[5]

The Supreme Court upheld the award over a challenge. It held that the capacity to be a party in arbitration proceedings depends on legal capacity. As the legal capacity is to be determined, based on the Swiss conflict of laws provisions, by the law governing the registration of legal entities, Elektrim’s legal capacity and the capacity to be a party in an arbitration proceeding were governed by Polish law.[6] The Supreme Court saw no reason to question the arbitral tribunal’s view that article 142 BA deprived a bankrupt party of the capacity to be a party in an arbitration proceeding and held that Elektrim had thus lost this capacity.[7]

B.            Critique

Numerous authors criticized the decision of the Supreme Court.[8] The principal criticism was that the Supreme Court had misconstrued the scope of article 142 BA by interpreting it as a norm regulating the capacity to be a party in a proceeding instead of the substantive validity of the arbitration agreement. In the latter case, the bankruptcy of Elektrim would have had no effect on the proceeding because of the principle of favor validitatis regarding arbitration agreements in article 178(2) Swiss Private International Law Act (hereinafter “PILA”).[9]

II.           Revision of Vivendi in 2012

In 2012, the Supreme Court had the chance to review the question of the effect of a party’s bankruptcy on the capacity to be a party in an international arbitration proceeding in Switzerland. In doing so, the Supreme Court approached the topic more carefully and rendered an elaborate decision clarifying its position.[10]

A.           Facts and decision of arbitral tribunal

In 2009, a controversy over an agreement, that contained an arbitration clause for arbitration in Geneva, arose between a Portuguese and a Chinese company. In August 2009, a Portuguese court declared the Portuguese company insolvent. Nearly a year later, the Chinese company initiated an ICC arbitration proceeding against the Portuguese entity.[11]

In light of its insolvency, the Portuguese entity disputed the arbitral tribunal’s jurisdiction.[12] It relied in particular on article 87(1) Portuguese Insolvency Law (hereinafter “IL”) which states: “Without prejudice to provisions contained in applicable international treaties, the efficacy of arbitral agreements relating to disputes that may potentially affect the value of the insolvency estate and to which the insolvent is party shall be suspended.”[13]

In an interim award, the arbitral tribunal concluded it had jurisdiction as the arbitration clause was valid and the parties were capable of being parties in an international arbitration proceeding in Switzerland.[14] It considered the arbitration clause to be valid based on article 178(2) PILA and case law stating that an arbitration clause survives the bankruptcy of a party under Swiss law.[15] Regarding the capacity to be a party in arbitration proceedings, the arbitral tribunal determined that Portuguese law was applicable and concluded that article 87 IL does not have any effect on the capacity of a party as it only addresses the validity of an arbitration agreement.[16]

B.            Law governing the capacity of a party in international arbitration proceedings

First, the Supreme Court determined the law governing the capacity to be a party in an international arbitration proceeding in Switzerland. In this respect, the Supreme Court noted that Chapter 12 PILA does not contain a provision regarding subjective arbitrability of non-state parties, and accordingly the capacity to be party in arbitration proceedings is to be determined based on the preliminary substantive law question of the legal capacity.[17]

Based on article 154(1) PILA, it held that the legal capacity of a legal entity is to be determined by the law of the state under which the entity is registered.[18] Thus, the Supreme Court came to the conclusion that Portuguese law governs the legal capacity of the Portuguese entity.[19]

C.           Definition of legal capacity and its consequences

Then, the Supreme Court referred to Swiss law to define legal capacity as the capacity to be the subject of rights and duties. It further concluded that if the legal capacity of an entity is to be determined based on foreign law, it must be analyzed if the entity is capable of having rights and duties under this foreign law. If so, the entity has legal capacity and capacity to be a party in an international arbitration proceeding that is governed by Chapter 12 PILA. The Supreme Court then held that specific restrictions regarding arbitration proceedings of the law governing the entity’s registration, which do not affect the legal capacity of the entity in general, have no effect on the capacity to be a party in arbitration proceedings in Switzerland.[20]

The Supreme Court then analyzed Portuguese law and concluded that insolvent entities are subject to rights and duties until the completion of liquidation in Portugal. Thus, the entity has legal capacity and capacity to be a party in an arbitration proceeding governed by Chapter 12 PILA. Even if article 87 IL hinders a Portuguese insolvent entity to be a party in a Portuguese arbitration proceeding, this would have no effect on the capacity to be a party in an international arbitration proceeding in Switzerland, as the only decisive factor for the proceedings in Switzerland is whether the Portuguese law assigns the entity rights and duties.[21]

D.           Comments to its Vivendi decision

The Supreme Court then addressed its Vivendi decision and pointed out that this decision needs to be seen in the specific context of Polish law and can neither be generalized nor the statements therein applied to the law of other jurisdictions. In particular, that decision does not confirm in a general way that foreign insolvency laws which declare arbitration agreements ineffective in the case of a party’s insolvency result in the loss of the capacity to be a party to arbitration proceedings.[22]

E.            Conclusion regarding subjective arbitrability

The Supreme Court upheld the award by concluding that article 87(1) IL has no effect on the legal capacity and the capacity to be a party in international arbitration proceedings in Switzerland. Pursuant to the Swiss lex arbitri, article 87(1) IL only addresses the validity of the arbitration agreement. But this question is governed by article 178(2) PILA, pursuant to which an arbitration agreement is valid if it conforms to Swiss law. Since under Swiss law an arbitration agreement survives the bankruptcy of a party, article 87(1) IL has no effect on this question either.[23]

III.        Comments

This new decision raises various issues. Among them are the characterization of the insolvency problem and its consequences, the effect of the lex concursus on arbitration proceedings and limits thereto of the lex fori, the difference between capacity to be a party in a proceeding and the procedural right to bring an action, the determination of the capacity to be a party in an arbitration proceeding, the applicable law on the definition of legal capacity of a foreign entity, the reliance on provisions outside of the lex arbitri and the application of foreign insolvency law as loi d’application immédiate.

Hereinafter, the characterization of the insolvency problem and the determination of the capacity to be a party in an arbitration proceeding will be addressed. The characterization deserves particular attention as it is the starting point in an analysis of the effect of a foreign insolvency and can have a significant effect on the outcome. The determination of the capacity is of practical importance as it provides the parties with a test to predict the consequences of insolvency with respect to international arbitration proceedings in Switzerland.

A.           The characterization of the insolvency problem

The effect of foreign insolvency or bankruptcy proceedings on arbitration proceedings in Switzerland mainly depends on the characterization of the problem. “[W]hether the insolvency of a party is an issue of capacity, of the binding force and scope of the arbitration agreement or a procedural question”[24] is a decisive factor, as it determines the applicable provisions of Chapter 12 PILA and therewith the law governing the issue of the foreign insolvency.[25]

As shown in the decision, the characterization can predetermine the effect of party’s insolvency on proceedings in Switzerland: If it is an issue of the validity of the arbitration agreement, a foreign insolvency law has no effect on an arbitration proceeding in Switzerland based on article 178(2) PILA, according to which an arbitration agreement is valid if it conforms at least to Swiss law, and case law pursuant to which the bankruptcy of a party does not affect the validity of an arbitration agreement under Swiss law.[26] However, if the capacity to be a party in an arbitration proceeding in Switzerland is the issue, the answer depends on the entity’s capacity to be the subject of rights and duties pursuant to the law of the place of the registration.[27]

In Vivendi, the Supreme Court characterized the problem of insolvency as one of capacity without explicitly addressing the question of characterization.[28] The absence of any reasoning in this regard was surprising as the minority of judges took the position during the public deliberation that it was rather an issue of the validity of the arbitration agreement than one of the party’s capacity.[29]

Likewise in its new decision, the Supreme Court characterized the insolvency problem as an issue of capacity:[30] It analyzed, without addressing the process of characterization, the question of insolvency as one of the capacity to be a party in an arbitration proceeding. Only after concluding that Portuguese law does not affect the entity’s capacity, did it hold that article 87 IL solely addresses an aspect of the substantive validity of the arbitration agreement.[31]

Hence, the Supreme Court has twice characterized the insolvency issue as one of capacity. As the characterization process was not explicitly addressed in either decision, it is not clear how the Supreme Court came to this conclusion. Under the presumption that the Supreme Court conducted a characterization of the insolvency under the lex fori, as earlier case law suggests,[32] and with a focus on the legal problem at issue and not the particular provision invoked,[33] it could be concluded that the Supreme Court will also in future characterize insolvency as a capacity issue. It might, however, be the case that the Supreme Court did not want to commit itself to such a characterization at this time. Be it one way or the other, it would be helpful to have an express ruling on this question to provide potential parties with predictability.

B.            Determination of capacity to be party in international arbitration proceedings

The Supreme Court held in its new decision that the capacity of a foreign entity to be a party in international arbitration proceedings in Switzerland depends on the entity’s capacity to be the subject of rights and duties under the law governing the entity’s registration. Restrictions regarding arbitration proceedings of the foreign law that do not affect the entity’s legal capacity in general will not be considered.[34]

At least here the Supreme Court provides the parties with predictability. This straightforward test to determine the consequences of insolvency on their capacity to be a party in international arbitration proceedings in Switzerland strengthens Switzerland as a place of arbitration by providing the mentioned predictability and by limiting the reach of foreign insolvency laws[35]. Thus, if insolvency is characterized as an issue of capacity, such foreign insolvency laws cannot prevent arbitration proceedings in Switzerland as long as the entity has legal capacity in the country of registration.

 

Simon Marc Hohler

The author is an LL.M. student in the International Business Regulation, Litigation and Arbitration program at New York University School of Law, Class of 2014. After graduating from the Universities of Lucerne and Neuchatel in Switzerland in 2008 (Bilingual Master of Law; J.D. equivalent), he gained working experience in Swiss and U.S. law firms as well as at the Cantonal Court of Zug, Switzerland. After being admitted to the bar in 2011, he worked in the Litigation & Arbitration Team at Blum & Grob Attorneys at Law Ltd. in Zurich, Switzerland.

 



[1]    Bundesgericht [BGer] [Federal Supreme Court] Oct. 16, 2012, 138, Entscheidungen des Schweizerischen Bundesgerichts [BGE] III 714 (Switz.).

[2]    BGer Mar. 31, 2009, 4A_428/2008 (Switz.).

[3]    Id.

[4]    Id. at B.b.

[5]    Id. at B.c.

[6]    Id. at 3.2.

[7]    Id. at 3.3.

[8]    For a list of the scholarship criticizing the decision see: BGer Oct. 16, 2012, 138 BGE III 714 (Switz.), 724-725 (3.5.2).

[9]    BGer Oct. 16, 2012, 138 BGE III 714 (Switz.), 724-725 (3.5.2); Article 178(2) PILA states: “Furthermore, an arbitration agreement is valid if it conforms either to the law chosen by the parties, or to the law governing the subject-matter of the dispute, in particular the main contract, or to Swiss Law”.

[10] BGer Oct. 16, 2012, 138 BGE III 714 (Switz.); See also Georg Naegeli, The Capacity of a Bankrupt Party to Be or Remain a Party to International Arbitral Proceedings, A Landmark Decision of the Swiss Federal Supreme Court, 31 ASA Bulletin, 372, 372 and 375 (2013).

[11] BGer Oct. 16, 2012, 4A_50/2012 (Switz.), at A.a, A.b and B.a.

[12] Id. at B.a.

[13] BGer Oct. 16, 2012, 138 BGE III 714 (Switz.), 716 (3.1.2.2).

[14] Id., 715 (3.1).

[15] Id., 715 (3.1.1).

[16] Id., 715-719 (3.1.2, in particular 3.1.2.4 and 3.1.2.5).

[17] Id., 720 (3.3.1).

[18] Id., 720-721 (3.3.2); In the absence of such a registration requirement in that law, the legal entities are governed by the law of the state under which they organized themselves (article 154(1) PILA in fine).

[19] Id., 721-722 (3.3.3 and 3.3.5).

[20] Id., 721-722 (3.3.4).

[21] Id., 722-723 (3.4, in particular 3.4.2).

[22] Id., 724-726 (3.5, in particular 3.5.3).

[23] Id., 726 (3.6); Thereafter, the Supreme Court analyzed if 87(1) IL applies as loi d’application immédiate but denied this (see id., 726-727 (4.)).

[24] Stefan Kröll, Arbitration and Insolvency – Selected conflict of law problems, in Conflict of Laws in International Arbitration 211, 241 (Franco Ferrari & Stefan Kröll eds., 2011).

[25] Id., 233, 241-242, 244 and 246.

[26] BGer Oct. 16, 2012, 138 BGE III 714 (Switz.), 726 (3.6); BGer Dec. 8, 2009, 136 BGE III 107 (Switz.), 108 (2.5).

[27] BGer Oct. 16, 2012, 138 BGE III 714 (Switz.), 719-722 (3.2 and 3.2);

[28] BGer Mar. 31, 2009, 4A_428/2008 (Switz.), at 3.

[29] Naegeli, supra, 373.

[30] Lara Pair, Entscheidbesprechungen, BGer 4A_50/2012, Aktuelle Juristische Praxis 615, 616 (2013).

[31] See above, II.B., II.C. and II.E.

[32] BGer Dec. 4, 2009, 136 BGE III 142 (Switz.), 144 (3.2).

[33] Kröll, supra, 244-245; Michael Günter, Internationale Schiedsgerichtsbarkeit und Insolvenz – Zur Berücksichtigung von Insolvenzverfahren und ihren Auswirkungen vor internationalen Schiedsge­richten mit Sitz in der Schweiz, 202 (§ 427-428) (2011).

[34] See above, II.B. and II.C.

[35] See also Naegeli, supra, 380-381.

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